Ind AS 109: How to calculate Effective Interest Rate and carrying amount of Borrowings : 30-10-2018

Query

An Ind AS compliant entity has borrowed Rs. 10,00,000 from a bank who has charged Rs. 91,760 as the processing charges. The coupon interest rate is 12% and the loan is repayable in 5 years in equal installments of Rs. 2,77,410. The bank disbursed the loan amount net of its processing charges.

How would you account for this transaction?

Answer

Ind AS 32, Financial Instruments: Presentation, defines a financial liability as a contractual obligation to deliver cash or another financial asset to another entity. Initially, a financial liability is measured at its fair value plus or minus transaction costs that are directly attributable to its acquisition. However, if the financial liability is measured at fair value through profit or loss, transaction costs should not be adjusted withfair value of the liability. The transaction price of a liability should be taken as its fair value, unless otherwise justified. Further, at the time of subsequent measurement, generally, a financial liability is measured at amortised cost which is calculated at initially recognised value of the liability plus interest amount calculated at effective interest rate minus amount of repayments of liability. Effective interest rate refers to the rate that exactly discounts estimated future cash payments through the life of a financial liability to its carrying amount.

In the given case, the entity has taken a loan which is to be repaid to the lender bank in cash over the period of 5 years. So, the loan is a financial liability. Accordingly, it should be measured initially at fair value less transaction costs, i.e., Rs. 9,08,240 (Rs. 10,00,000 – Rs. 91,760). Subsequently, the loan shall be measured at amortised cost. For this purpose, the entity has to calculate the effective interest rate which will come at 16%, as follows:

Present value of cash outflows at 16% for 5 years:

= Rs. 2,77,410 * Present value annuity factor of 16% for 5 years

= Rs. 2,77,410 * 3.27

= Rs. 9,08,240

Under amortised cost model, the loan shall be measured as follows:

Year Opening balance (1) Interest (2)
(1 * 16%)
Historical cost (3)
(3-5)
Interest paid (4)
(3 * 12%)
Principal repaid (5)
[(2,77,410)-(4)]
Amortised cost at the end of year (1+2-4-5)
1 9,08,240.00 1,45,318.40 10,00,000.00 1,20,000.00 1,57,410.00 7,76,148.00
2 7,76,148.00 1,24,183.74  8,42,590.00 1,01,110.80 1,76,299.20 6,22,922.14
3 6,22,922.14  99,667.54  6,66,290.80  79,954.90 1,97,455.10 4,45,179.69
4 4,45,179.69  71,228.75  4,68,835.70  56,260.28 2,21,149.77 2,38,998.44
5 2,38,998.44 38,411.56 2,47,685.98  29,724.02 2,47,685.98 0.00

 

Under amortised cost method, the amount of transaction costs are amortized over the period of liability in the form of interest. In this case,

Total interest as per effective interest rate= Rs. 4,78,810

Total interest paid to the lender bank= Rs. 3,87,050

Difference between the above is for loan processing fees= Rs. 91,760

 

Journal entries

 1.  At the time of taking loan

Bank A/c Dr. 9,08,240.00
        To Loan A/c 9,08,240.00
(Being loan taken & measured at fair value)

 2.  At the end of 1styear

(a) Interest Expense Dr. 1,45,318.40
        To Loan A/c 1,45,318.40
(Being interest due for the year)
(b) Loan A/c Dr. 2,77,410.00
        To Bank A/c 2,77,410.00
(Being loan and interest thereon repaid)
(c) Statement of profit & loss Dr. 1,45,318.40
        To Interest Expense 1,45,318.40

Similarly, the interest of Rs. 124,183.74; Rs. 99,667.54; Rs. 71,228.75 and Rs. 38,411.56 should be booked in subsequent years.

 

Source : PTI

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